Last week, I had lunch with a young entrepreneur who had just read The Silicon Lathe and gave it a great review. In his career so far, he's had many similar experiences - companies mismanaged, disruptive technologies killed by larger players, unethical CEOs, people who steal what they want rather than building it, and even patents stolen. I'll likely incorporate some of his experiences in future novels.His current venture ran into several of these problems (including technology theft), but he has persevered and landed his first round of significant funding with his second on the way. He has over 30 employees with product placed in several Fortune 500 companies and some government entities. He did bootstrap his company, however. Initially, he self-funded development of a security product on his own time. He then discovered that Stanford Research Institute (SRI) had complementary technology. Seeing a nice fit, he worked with SRI to productize their offering mostly on their nickel. Much like customer funding, finding a university or research entity that would like to see their work turned into commercial product is a great way to initially fund a product. Some of his initial customers were investors in Private Equity Funds and once he had proven technology in a commercial environment, they helped him raise money from one of these funds. In his case, he was quite lucky as the terms of the deal left him with much more of the company than a Venture Capitalist (VC) would have. In addition, because the customers were 'invested' in his success, they have been helpful without interfering, and are not looking for the quick exit that many VCs expect. They're looking for product that meets their unmet needs.Hopefully you're seeing a recurring theme here. Bootstrap, bootstrap, bootstrap. Avoid outside funding as long as possible, and avoid VC funding until it's essential. If you have a sustainable business model, you should be able to launch your venture with a combination of customer funding and limited private investment (of which some would be your own). You should be able to build an strong balance sheet that will put you in a solid position if you ultimately need significant investment to expand the business, accelerating a working model. I recently ran across an interesting blog by David Spinks (CEO of Feast) called 7 Signs You're Fundraising Too Early. The author is an entrepreneur who declares himself guilty of trying to raise funding too early. I strongly suggest you read his blog, but if you can't, here are some of his 7 signs:

You start adapting the product based on the fundraising landscape.

You feel you have to invent traction.

You're raising survival money at the seed stage.

Friends and advisors give you excuses.

Bottom line, if your business plan is not clear and you're not on track, you'll start acting desperate - changing your business/product plans with the investment winds, struggling to look better than you are, and perhaps not understanding why your friends and advisors aren't willing to commit their own funds. You're not ready for investment because you need to get your house in order first. As mentioned above, significant funding should be used to accelerate your proven business.In my next post, we'll talk about VC funding and what to avoid if you can. Then we'll come back to alternative funding mechanisms.

Before diving much deeper into funding, I thought it might be worth doing a post on structure of the company from a tax/income point of view. We'll get into internal personnel organization in later posts.One of the first things you'll be faced with in starting your business is whether you should be a sole proprietor, partnership, LLC, S-Corp or C-Corp. As a sole proprietor, your company is an extension of you, yourself. From an income point of view, all income goes directly to you and all losses come out of your pocket. In addition, you have direct responsibility for anything that you, your company, or your employees do that may make you liable to legal or debt actions. You can protect yourself from this liability by securing insurance for your business. Generally a sole proprietorship is suited for a small self-funded business that will face limited exposure in terms of potential legal liability. There is no basic structure to allow investment into the company so you'd need to make private arrangements (typically loans) for any funding you can't provide.Partnerships are similar to sole proprietorships except that the ownership, profits and expenses are divided among the partners according to their percentage of ownership. While partnerships work in some cases, I've seen many situations where a partner isn't carrying his or her load, where a partner wants to leave the company, where a spouse decided to intervene, and many more problems that in my mind make this a challenging structure for your business. If I were looking for a partner-like structure, I'd probably pick an LLC instead.An LLC or Limited Liability Company has the structure of a partnership where the income and expense pass through to the owners like a sole proprietorship or partnership. Its primary advantage is that it adds a layer of liability protection. Its simpler to form than a corporation and doesn't require the formality of a corporation (e.g. board and shareholder meetings). In our country for good or bad (e.g. campaign contributions), a corporation is considered to be an individual and thus, many liabilities go to the corporation itself and don't pass through to the owner(s). This is called the 'Corporate Veil'. Many expenses like healthcare, retirement monies, equipment and software purchases, inventory, etc. can be assigned to the corporation even if they benefit the owners. For an entrepreneur looking for investment and for potential exit, a corporation may be the best choice. Note that forming a corporation has costs and in states like California, there is often a minimum tax payment after the first year, even if the company has no income. The simplest corporation is an S Corporation. An S Corp is like a sole proprietorship except that you have some protection of the 'corporate veil'. You are limited in the number and types of shareholders you can have but you can provide stock in exchange for investment. All income passes to the shareholders. This may be the best choice if your goal is to take as much money out of the company as possible but to have the protection of a corporation.One big advantage of an S Corp is in Social Security Taxes. I expect that at some point, this loophole will be closed, but under current law, shareholder distributions (profits) are not subject to Social Security Taxes. That is, the corporation could pay you a salary of say $70,000 per year, and if you had profits of $30,000 in a given year, you'd pay no Social Security tax on that $30,000. You do need to draw a 'reasonable' salary. That is you can't take a $1 salary and pay yourself $99,999 in profits. Note that all profits in an S Corp are assumed to be distributions to you and are taxed accordingly. S Corps are limited somewhat in the number of shareholders and if you're thinking of going public, you'll need a C corporation. In addition, because of the flow-through of income and expense, there is less protection for the shareholders than in a C corporation. And, in a C corporation, you have more flexibility in terms of how you recognize revenue and expense. C corps are much better if you think you're going to do reinvestment in your company as opposed to taking all the profits every year. Profits in a C Corp may be doubly taxed if you try to touch them. You'd need to declare a dividend after paying corporate tax on the profit, then those receiving the dividends would also be taxed on the dividends.Bottom line, if you're looking for outside investment, are thinking you might want to go public someday, want as much protection as possible and want to invest in the growth of the company, minimizing those taxes, go for a C corporation. In all cases, you'll need a business license, even if you decide to operate the business out of your home. For a sole proprietorship or partnership, you'll also need to file a fictitious name statement. You don't need to do that for a corporation because a corporation is a legal entity itself and has a name granted by the state.

Now you should choose the structure of your business and the type of funding you'll need. Going back to why you're starting a business, what is your overriding motivation? I posed a few questions in Part 1, but of these, what is your priority?

Do you just want a decent income that can support you, your employees and your family, giving you independence?

Do you want to get rich?

That's not to say that you won't get rich with (1), but if getting rich is your primary motivation, then your approach will be quite different.

Let's start with (1). You want control, independence, and a decent income that can support you and your employees. If an IPO is in your future, it's at least 4 or 5 years off.

If control is a priority, then most likely you won't want outside interference in your business. You probably don't want to go the route of seeking seed funding followed by larger venture capital investments. Your choices then include the following (in order of the degree of control you maintain):

Bootstrap the business.

Borrow funds to get started.

Crowd Funding.

Angel/Private Investment.

I'll discuss Bootstrapping in the rest of this post and the others in future posts. Note that borrowing funds can be risky. You can borrow from friends and/or family, but you might be surprised how much they want to help. Getting loans obligates you to payments which you need to be sure you can meet.

Crowd Funding sounds good, but new SEC rules make this less attractive. See I Would Still Pass on Crowd Funding.Angel/Private Investments offer an attractive possibility though you will give up some control. We'll go into that in a future post.

I must admit that my favorite way to start a company (I did it three times this way) is bootstrapping. In reality, even if you decide to go big with full-on Venture funding, you'll probably need to bootstrap at least enough to get a prototype built or to demonstrate the concept of your product/service.

With the tools available today, you may be able to kick off your startup while you're still working at your present job. Of course you need to be careful to ensure that your employment agreements, in particular patent and confidentiality agreements, don't prohibit you from doing this. Be very careful here. You also need to be careful in contacting clients of your existing employer. In California, again depending on agreements with your employer, this is usually allowed if your contact is informational and doesn't solicit - "I just wanted to let you know that I've left XXX and am now working for NewCo. My contact information is..."

Note that even if you've left the company, you may be subject to restrictions on information you use or even skills you've learned. Check your employment agreements!

Ultimately, in an ideal scenario, you start your business while continuing your previous job. This means you don't have to pay yourself a salary or benefits.

Often, a good way to start is to begin by offering services - consulting or software development. This makes you profitable from day one. It can also be a good way to do additional market research - consult for your target market and you'll get real insight into what your customers really want/need.

In my first startup, I began by consulting to enterprises who needed unique networking and security products. This involved assessing their requirements in detail, researching what was available in the marketplace and making recommendations for specific products and services, noting the current market deficiencies.

People talk about luck and I guess I was lucky. But I believe you make your own luck by positioning yourself to be ready when opportunities arise. In my case, after a few contracts, I found customers willing to pay for development of products that weren't found on the market in exchange for unlimited licenses (in that case it was software) or for a much reduced guaranteed price (a hardware/software product).

I bootstrapped my second startup through a combination of consulting and contract software development. I hired employees and contractors to do development and banked the profits until I could afford to leave my then-current employer and fund our own product development.

Bottom line: if you have a product or service you can offer use that to raise your initial funding and you'll be in a much stronger position if/when you decide to raise additional capital.